The neatly mowed roadsides or parks and clean streets of American suburbia often owe their carefully maintained look to the rotary mowers, street sweepers, and vacuum trucks Alamo Group (ALG 6.69%) manufactures. Focused until now on selling municipalities the vehicles necessary for public space upkeep, the company completed a $325 million acquisition of Morbark on Oct. 24. Alamo Group establishes a strong foothold in the logging gear sector with this purchase, positioning itself for significant near-future growth thanks to powerfully increasing demand for forestry equipment nationally and worldwide.
Entering a product sector with plenty of room for expansion
Graduating from trimming grass to felling trees via its Morbark acquisition, Alamo Group enters a market with strong projected growth over the next few years. High global demand for housing and furniture, driven in part by the Asia-Pacific region's large new middle class, creates a rising need for equally large quantities of quality wood to process into finished goods and homes.
Harvesting this wood requires forestry equipment. According to some reports this sector will mushroom at a 4.9% CAGR (compound annual growth rate) through 2024. By then, the projections claim, total equipment sales will top $10.5 billion annually. Alamo Group can now compete for a piece of that windfall thanks to its acquisition. Morbark builds mulchers, stump cutters, crawler trucks, flails, compact wheel loaders good for extracting felled timber from difficult terrain, and other vehicles or devices used widely in logging and silviculture.
Alamo Group faces competition from both domestic and foreign rivals. One of these, Deere & Company (DE 5.25%), better known as John Deere, is reeling from the farm sector trade war with China, perhaps giving Alamo more room for expansion. But Morbark's robust position in the forestry equipment sector brings Alamo up to speed with its competitors right off the bat.
The newly acquired company's net sales amounted to $225.5 million in 2018. Its 2019 sales through the end of September already left that sum in the rearview mirror at $235.9 million. Company guidance predicts total 2019 net sales of $245.0 million. Alamo's long experience with industrial equipment manufacture and marketing make it an excellent match for Morbark, with the know-how necessary to build even greater combined success.
Potential growth in the wildfire fighting industry
While the housing and furniture uses for round wood provide the biggest source of forestry equipment demand, the 21st century rise in destructive wildfires sparks additional sales, too. While changing climate might affect the sharply rising amount of property damage inflicted by forest fires, the recent trend of constructing developments in high-risk areas contributes even more. New building in these dangerously fire-vulnerable zones, called the wildland-urban interface, jumped by over 40% between 1990 and 2010, and continues to grow.
Morbark's mulching machines are just what the forester ordered for proactively defending valuable new homes from wildfire risk. These tracked vehicles can be used to create partial firebreaks to protect nearby homes, cutting the risk of wildfire damage or destruction. Selling mulching machines and related equipment may help Alamo Group tap into the approximately $3 billion spent annually in preventing and fighting wildfires.
Alamo's net sales increase, net income should rebound
This company has plenty of potential even before investors consider the new possibilities of the Morbark deal. Alamo Group's Q3 2019 earnings show that net sales set a new record with a 5.5% quarterly jump. Net income, on the other hand, dropped by 6.3% for the first three quarters of 2019 compared to the same period in 2018, providing $4.52 per diluted share versus 2018's $4.84 per diluted share.
The reason for rising net sales and falling net income isn't hard to understand. The money used to buy Morbark – plus two other acquisitions, Dixie Chopper and Dutch Power – put a dent in income despite vigorous sales. Dixie Chopper is an industrial lawnmower manufacturer related to Alamo Group's core business, while Dutch Power is a European vegetation management machines maker whose products also mesh with the expanded Alamo Group and Morbark lineup.
However, demand for Alamo Group's core products in the municipal infrastructure vehicle sector is strong and growing. ALG's actual P/E ratio in 2018 was 19.66, improving to an estimated 2019 18.81 P/E and estimated 2020 14.52 P/E. This will bring the company nearly on par with rival equipment maker Caterpillar's (CAT 8.40%) estimated 2020 P/E of 13.53, and betters Husqvarna's(HUSQF 4.97%) current 21.81 P/E. Combined with a profit rebound as forestry equipment sales kick in moving into 2020, this factor makes Alamo Group a company worth considering for investment.